This article was sponsored by NREP. It appeared in the Residential supplement with the June 2019 issue of PERE magazine.

The strongest population growth in Europe combined with a millennial generation ever keener to live and work in large cities, but lacking the income to buy their own homes, mean the Nordic countries are facing high demand for rental apartments. But currently, there is a lack of supply to fulfill the need. For investors, this signals opportunity, and NREP, as one of the regions leading developers and investors in real estate with €4.3 billion of assets under management, is aiming to plug the gap by capitalizing and developing a new generation of modern rental homes.

PERE talks to the firm’s Helsinki-based partner Mikko Räsänen about the intricacies of the Nordic markets and the growing importance of adopting a tenant-focused approach to property investing.

What factors are driving demand for rental apartments?

Mikko Räsänen

The Nordic region has stronger population growth than any other region in Europe, and is also experiencing strong urbanization rates. Stockholm, Copenhagen, Oslo and Helsinki are four of the five fastest growing capitals in Europe.

On top of the population growth, an increasing number of people living and working in our capital cities cannot afford to buy an apartment, so they are turning to the rental market. This is especially the case among the younger generation, whose incomes are typically lower. Furthermore, as much of the added incremental rental population live as singles or couples rather than as families, more apartments are needed to house the same amount of people.

This demand growth should be seen against a general supply that is hampered due to very slow and iterative zoning processes. In addition, regulation of rents further hampers the supply of rentals, thus causing a significant supply-demand imbalance.

How would you describe the current residential real estate market in the Nordic region?

While the demand growth is a common characteristic, each of the Nordic countries are indeed local markets and differ in many important ways, such as regulatory, structural and cyclical factors. Starting with regulation, the residential-to-let segment is partly regulated across all Nordic countries, but Sweden is unique due to all-encompassing rent-control legislation limiting what landlords can charge for rental apartments, thus limiting income return potential, especially in the largest cities. Strictly regulated rent levels in Sweden mean that tenant demand overwhelmingly exceeds apartment supply and tenants often queue for several years to get one. In Denmark and Finland, regulation relates to older assets. Copenhagen and Oslo also have rules around average apartment sizes in new buildings, which limits the supply of smaller and affordable rental apartments. Against that backdrop it is not surprising there is literally no vacancy in the capitals and growing cities in the Nordics.

Structurally, ownership is highly favored in the Norwegian market, while Denmark is a rental market. Finland and Sweden are somewhere in between. From an investment perspective, because Norway is so ownership-focused, a proper liquid investment market for multifamily rental buildings is largely absent whereas Denmark, Sweden and Finland offer a highly liquid market for investors.

Cyclically, the markets are also at different points. Stockholm’s residential market is the furthest along in the cycle and after years of increasing prices, the develop-to-sell market recently experienced a slowdown with apartment prices declining by 10 percent. That has led to many developers facing financial problems, and an increase in the supply of rental apartments as a result of a growing number of developers converting develop-to-sell projects into rental projects.

Copenhagen and Oslo also have rules around average apartment sizes in new buildings, which limits the amount of smaller and affordable apartments that can be brought to market, so while demand is growing in this segment, supply is constrained, and rents for small apartments has been growing fast.

To make the right decisions, investors need to be familiar with the local subtleties.

In terms of strategy, how are investors approaching the sector?

The Nordic markets provide opportunities for investors across the spectrum, from core to opportunistic.

Large amounts of capital are competing to buy core residential rental assets in the large cities, which is considered by local institutions and banks as one of the safest assets you could own. Supply is limited and there is significant competition every time there is a large portfolio or significant asset for sale. Hence, in addition to struggling to get sufficient volume, many institutional core investors are struggling with historically low yields.

One way for value-add investors to improve yields and returns is to do forward purchasing or forward funding of residential-to-let projects from local developers. Investors can push away many development risks to other market participants, and the reward, if done successfully, is to obtain access to a high-quality rental building at a price point that is well below the market value of similar standing assets.

A smaller number of opportunistic investors are pursuing a strategy of buying regulated older assets, refurbishing those assets and then trying to increase rents. This is a strategy that certain investors have pursued in the Swedish market in particular. The other strategy that certain opportunistic investors have been embracing is buying assets of various quality in the smaller regional cities where the general outlook is not as positive compared to the larger cities. This allows these investors to purchase assets at higher yields, but on the other hand liquidity risk is clearly higher and the rental market outlook is not that positive.

Another opportunity in the Nordics, as many of the segments are less mature compared to, for example, the UK or Germany, is to improve initial and long-term rental yields by developing multifamily rental residential that is more tailored to consumer demand and needs than the typical standard existing product offering. And this is a space that NREP finds particularly interesting and is very active in.

How important is it to have a tenant-focused approach to residential developing and investing these days?

Both old and new rental stock tend to be of lower quality than in the for-sale space. But because demand has outstripped supply in most Nordic markets, owners have been able to let their apartments regardless. As a result, there has been no competition between owners to adopt differentiated products and services. That is likely going to change going forward.

To ensure portfolios are fit-for-purpose in the long-term, it is increasingly important to a have customer- or tenant-focused investment approach. While the pace of change differs between the Nordic markets, we are seeing a general trend of tenant expectations growing in terms of what they want from a rental property. They seek flexibility and convenience from their homes, and they demand better quality and with a price tag attached that is reasonable to their incomes. For example, tenants are now showing a preference for modern and good quality smaller apartments; single people and couples without children are a growing demographic, and they have less need for large living spaces. Owners need to be attuned to these subtle dynamics at play and respond.

And certainly differentiation is something NREP is very focused on achieving. We have already developed more consumer-focused concepts for student housing, serviced living for young professionals as well as for active seniors and families with children. Each of these concepts are tailored for a specific customer group and bring something new to the Nordic markets. Noli Studios, for example offers affordable yet hassle-free flexible living for young professionals with various services such as cleaning, gym and communal facilities on the ground floor. Our Plushusene concept in Denmark offers communal spaces where residents can have dinner together and spend time with neighbors. We also see significant untapped potential to provide more consumer-focused concepts for the general residential rental market in the Nordics, improving the quality of life for residents without increasing costs.

A living environment that promotes health and well-being is fast becoming a key consideration for the modern tenant. Poor air quality has been a topic of debate across the region, so we can expect to see demand for residential property to have better air quality and ventilation. The younger generation in the Nordics ia also more concerned about energy efficiency and the environmental impact of property. Property owners and investors must also respond to these types of sustainability considerations. You can no longer get way with selecting the cheapest option or the easiest route when developing a new rental property. We are beginning to see more renewable energy being installed in properties and more low-carbon building material being used. And wooden construction is finally picking up in the Nordic region, and modular construction techniques where buildings are assembled in factories.

What is your outlook for the next year?

Multifamily rental in the Nordic capitals and growing cities is underpinned by demographic growth trends that are projected to continue for the coming decades and supply constraints that are unlikely to disappear in the short term. Hence, part of the attraction of owning a high-quality rental product is that as a long-term investor focused on your rental income you do not need to worry about the outlook for the next year.

That said, to answer your question with regards to opportunities for new investments over the coming year, we expect the residential rental markets in Copenhagen and Helsinki to continue offering the most attractive risk-reward balance, but potentially the recent slowdown of the develop-to-sell market in Stockholm may open a new window of opportunity to buy land or completed projects from distressed local developers.

Case study: Plushusene
NREP’s co-living concept is deliberately customer-focused, designed to enrich the lives of young families and active seniors, and bring the two demographics together

Currently, NREP has two sites in development with 220 units and a total of 215,280 square feet, and a further pipeline of 1.07 million square feet planned for the near future. Here are some facts that support co-living as a long-term opportunity for investors, while also delivering value for its tenants.

• By 2030, seniors above 55 years will account for 35 percent of the population in Denmark (Statistics Denmark);
• 104,000 seniors in Denmark feel lonely (RealDania);
• 74 percent of people aged 55-80 prefer living together or close to families with children (NREP study);
• 89 percent of families with children prefer living close to people aged 55-80 (NREP study);
• 91 percent of people in co-living residential have experienced an increase in their quality of life (SFI, 2016);
• There is a demand gap of 100,000 co-living units in Denmark (NREP survey).